This paper investigates whether investors price the option to abandon the continuing business investmenet in exchange for the assets’ exit value in the Korea capital market, using the Berger, Ofeck, and Sway’s empirical model (1996). The abandonment option is equivalent to the American put option on a dividend-paying stock with a stochastic strike price (exit value) and a stochastic value of the underlying security (the present value of cash flow; PVCF).
This thesis also tests whether investors use balance sheet information about a firm’s assets to value the abandonment option. The exit value is estimated in terms of book value and the exit value for major assets classes. The empirical implications are that the firm value and abandonment option value increase in the exit value, after controlling for the relationship between market value and the PVCF.
Option-pricing theory suggests that the abandonment option’s value is affected by the probability of the option being exercised. This study attempts to find support for the prediction that less-specialized asstes produce an abandonment option of higer value, and that firms with high probabilities of financial distress have market values that are higher and more sensitive to variation in estimated exit value.
